Always keep Cash on Sideline

It is important for an investor to keep cash on the sidelines just as it is vital for a police officer to carry around with him extra ammunition. Many investors think and act counter intuitively when it comes to how much cash to hold on the sidelines. During the peak of bull markets, it is well characterized, that most investors hold very little cash on the sidelines. This is ludicrous as the risk/return ratio works against you when stock prices are high. Just like clockwork, at the end of a bear market, most investors hold too much cash on the sidelines out of fear.

I would argue that having cash on the sideline can only improve the risk part of the risk/reward equation. Sure, it is quite possible that you may regret holding the cash when equity prices rally. This is part of the logic as to why when stock prices appear undervalued one should hold less cash on the sidelines. Sure enough when stocks appear overvalued one should hold more cash on the sidelines.

Most investors don't see the benefits that holding cash has to the reward part of the risk/reward equation. However, having cash on the sidelines can be a huge asset to aid in your returns. Nobody is smart enough to time every stock move so having that extra cash as ammunition allows you to add to positions as a stock drops. Therefore, as that cash gets put to work, you are automatically investing in a stock that has better risk/return characteristics.